Wednesday, November 11, 2009

New Open Forum

Yes, of course every country needs a basic financial system to function effectively with letters of credit, deposits, and check writing facilities, etc. But as you move beyond that it is worth remembering that every valued job created by financial complexity is paid for by the rest of the real economy, and talent is displaced from real production, as symbolized by all of the nuclear physicists on prop trading desks. Viewed from the perspective of the long-term well-being of the whole economy, the drastic expansion of the U.S. financial system as a percentage of total GDP in the last 20 years has been a drain on the health and cost structure of the balance of the real economy. To illustrate this point, in 1965 the financial sector of the economy took up 3% of the GDP pie. The 1960s were probably the high water mark (or one of them) of America’s capitalism. They clearly had adequate financial tools. Innovation could obviously have occurred continuously in all aspects of finance, without necessarily moving its share of the economy materially over 3%. Yet by 2007 the share had risen to 7.5% of GDP!

The financial world was reaching into the GDP pie and taking an unnecessary extra 4%. Every year! This extra rent is enough to lower the savings and investment potential of the rest of the economy. And it shows. As mentioned earlier, the growth rate of the GDP had been 3.5% a year for a hundred years. It had proven to be remarkably robust. Even the Great Depression bounced off it, and soon GDP growth was back on the original trend as if the Depression had never occurred. But after 1965, the growth of the non-financial slice, formerly 3.4%, slowed to 3.2%. After 1982 it dropped to 3.1% and after 2000 fell to well under 3%, all measured to the end of 2007, before the recent troubles. These are big declines. It is as if a runner has a growing and already heavy blood sucker on him that is, not surprisingly, slowing him down. In the short term, I realize that job creation in the financialindustry looked like a growth driver, as did the surge in financial profits (which we now realize were ludicrously overstated). But in the long term, like a sugar high, thisstimulus was temporary and unhealthy.

The financial system was growing because it could. The more complex and confusing new financial instruments became the more “help” ordinary citizens needed from the experts. The agents’ interests were totally unaligned with the principle/clients’ interests. This makes a mockery of “rational expectations” and the Efficient Market Hypothesis, which assumes (totally unproven, as usual) equivalent and perfect knowledge on both sides of all transactions. At the extreme, this great advantage in knowledge and information held by the financial agents has the agents receiving all the rewards, according to the recent work by my former partner, Paul Woolley, and his colleagues at the Woolley Centre for the Study of Capital Market Dysfunctionality. (With a great name like that their job is half done before they start.)

55 comments:

Anonymous
said...

Mortymer:IMO: Reaction to few news - Saudis going from the index (lets follow oil moves).- More CBs gold purchases.- Many waited if 1100 will be the bottom or not = same as on 1000 line.- Avalanche effect.- Some BIG news soon.- Connection to moves in CDS???- New big entity bellyflop?Something to add?

Mortymer:Intersting: 1/ 18th of November will be chosen EU president... hmm, what gold will say? 2/ Local small currency CZK which is tied economically with Euro (Germany oriented) and has been manipulated for quite a time by GS goes up. (I have not found any other reason for this yet)I see maybe more than there is but I feel that those small issues are interconnected.

The articles on money by Mish I linked yesterday are worth your time.Mish does not deserved to be bashed, he has an interesting and refreshing perspective on some things, and he is all but unintelligent. I certainly do not agree with everything he writes, but some of his posts really are worth reading, especially the ones I linked yesterday.

Mortymer:I like him also and I have the same opinion about him as Martinj. Have you realized he did not write about gold for some time? I think he knows, he wrote about rise i ngold some time ago but his perspective is just a bit from side.

reserve backing for all deposits. To do this, the US Treasury loans them (at interest)

freshly printed US currency to bring their cash reserves up to 100 %. Treasury paper held

by banks, gets credited against these borrowings; canceling an equal amount. Banks are

then confined to lending existing funds."

"This elegant reform transforms the private bank credit money created out of thin air for

decades, into US legal tender -- real money. All US debt held by the banking system is

canceled out by the banks borrowings from the Treasury. Banks become panic proof, with

cash to pay all claims."

"This reform wouldn't be inflationary or deflationary - it simply makes tangible what had

been thought to be the existing money supply. This reform removes the money issuing power

from private banks and places it in the US Treasury. Its not paper money that's immoral;

its the private issuing of it."

Letting private institutions (banks) create money is like letting the home team referee it's own game. And guess what, the home team always wins. As you have witnessed, the big banks have won, everyone else has lost.

1) Is there a benefit to smaller than one ounce coins (e.g. 1/4 maples) and smaller bars (5 or 102) despite slightly higher premiums, in that they are more utilitarian/tradable because their value won't be quite to the moon like their larger denomination counterparts. If/when Freegold happens and we see massive deflation when priced in gold, is it better to have smaller denominations for barter/trade? Will ounces and larger become too valuable for all but the largest of life's private, individual transactions?

2) Not really numismatics, but if/when Freegold happens, it seems it would involve a lot of black market or private transactions. In anticipation of this, is it better to favor more commonly known gold mediums, like libertys or maples, as compared to less common or less standard gold coins, like special edition coins or other uncommon gold mediums? It seems trust and counterfitting are obvious potential issues if/when the dollar collapses and/or Freegold emerges, is this to be kept in mind and how can one think about being prepared for these issues?

The more oz the better if gold goes nuts. Why pay the premium now. Take the oz now.

Per FOFOA, gold won't be a medium of exchange going forward anyway, so size of gold won't matter to you. What will matter is how much wealth do you have to transfer to "money" or the "coin of the realm".

So do what you think is best but I think more oz gold is better than less oz gold, but that's just my opinion.

Tom, coins that are lower purity weight more than 1 oz so that the gold content is the same. If you melted it down to extract the gold, it's the same amount. Other alloys are added to the less pure coins to give them durability.

So basically, it doesn't matter unless you intend to handle the coins a lot.

@allenRe: "So basically, it doesn't matter unless you intend to handle the coins a lot."

Well said. Who needs a stash of 24Kt Canadian Maple Leafs, Credit Suisse Bars, Chinese Pandas, Australian Kangaroos, Austrian Phillies or etc. with a lasting record of smooch and fondle impressions for all the world to see!Why do you think the American Eagle with that woman on the front is 22Kt? ;)

Finally, on small coins. Small coins are the best for everyday/utility transactions. The problem is premium. I would caution you against taking an advice of this kind: "Who cares for the price, just get it!".

With even a minimal examination of this thought, you would see that the one who cares will have more bullion, than the one who doesn't.

Now, if you have a source of smaller coins (less than an OZ), at the same premium, by all means get them. Same goes for smaller bars (not flakes).

If you are like me, however, then you will discover that smaller than 1 oz coins and bars are at a premium everywhere. This is simply a "retail business model" working.

So, in a real world, I would say try to get some small and some 1 oz denominations. How much?

Take into account all the funds you will convert to cold. While denominated in USD, which part of those funds could be needed to pay for living for say a couple of years? This percentage is desirable to have in small denomination. The rest, I would say should be your investment quality coins/bars.

Many take silver to use in the role of small gold coin. Personally, I advice against Silver, because it is industrially consumed. It is, therefore, not money.

Silver without question is a monetary metal; has been for thousands of years. while I prefer gold myself, the vast majority cannot afford to purchase this metal of kings. I consider myself fortunate to hold gold but value silver as well (along with Pt and Pd). We are truly fortunate having such a forum and foresight. IMHO

Thank you for this MAJOR article. It proves my point... During my trip in Argentina, I saw many droughtzones in the north of Argentina.

Uruguay is much better located. Many water sources for your cows...

Also an interesting point of Uruguay is a very low criminality... A too nice place to live...

Also they have suffered hyperinflation and are also adjusted in this inflationary environment (they know how to live with this problem). You could live here without any fear for big problems... (America faces these BIG problems, like mass protests, hunger, criminality, rapings,...)

Uruguay is also a neutral zone, they aren't involved into brawls that could lead to WWIII...

A safe heaven...

Greetz

Yann November 11, 2009 7:17 AM

Jimmy said...

Total asks for handguns are a rising factor in America, prices of light guns are also rising... Maybe is there also a shortage? Or is it more?

Also an good example of our recent history is hyperinflation in Bosnia-Herzegnovia. This lead to war between the locals and Muslims. A cruel history...

http://en.wikipedia.org/wiki/Yugoslav_wars

http://en.wikipedia.org/wiki/Socialist_Federal_Republic_of_Yugoslavia

http://en.wikipedia.org/wiki/Yugoslav_dinar

(looks at the data: 1991 began the war and check the value of dinars: They added 5.000 dinars and then in 1992 begins the hyperinflation...)

Or read these books:

The globalization of poverty; Michel Chossudovsky

The schockdoctrine; Naomi Klein

Corporatism; Jeffrey Grupp

The blood bankers; James S. Henry

Muslim Mafia; David P. Gaubatz

And many books on amazon.com

And why could this be ugly in the near future:

http://www.presstv.com/detail.aspx?id=107575&sectionid=351020104

http://ipsnews.net/news.asp?idnews=46949

And do any know why Europe is so pressed to have one president? Before never talked about presidentship in Europe because, we were not ready for it... And now, so urgent seeking for a new president, without asking the people to vote for it?

Yes, I am aware of Eric. He runs a good blog. I agree, there is a perfect storm brewing for shortages of all kinds on a global scale. This is another reason to make sure you own gold. You cannot know for sure what you will need, nor how much you will need of it if things progress to their most difficult possible scenarios. Food can certainly be hoarded and I do advise that much of this be done. But how much? How far do you go to protect your family and your close neighbors? Much is uncertain in the future. Yet other things are near certain.

Soon I will be writing a short post called "Beyond gold". In the comments under this post perhaps we can help each other make the minimal preparations for the myriad possibilities that threaten our current standard of living. Keep an eye on the right hand column for a link as this post will be buried deep in the blog.

What to do? I work at a financial advisory group / stockbrokers. For the past year I have been openly discussing the problems we are all so familiar with. I have sent numerous emails to subtly (and sometimes bluntly) advocate buying physical gold. NO ONE gets it - some portfolio managers own GLD but mainly as a momentum trade. Although a couple of colleagues politely read my emails I sometimes feel slightly 'outcast' as if I should join the 'goldbugs' in the corner.

"It has no yield"! "XYZ is trading at 100x P/E (referring to some gold miner)! "I don't have a personal army to guard it"!

are some of the usual comments.

Yet they will deposit their life savings in a bank, with no yield!!!

Some say the "hype" reminds them of the dotcom bubble but they are not buying, neither are clients!

When I say the bubble is in paper their eyes glaze over.

So I have given up! I now smile politely whenever gold is discussed and think about my physical stored at home (with a bit imagination its not hard). Peace.

These are 'investment professionals'. What chance does the man in the street have?

Yes, I had seen a couple of those articles even before you posted them. As you can imagine, it is a lot of work for me to read and comment on everything that people post here. But out of curiosity, does it bother you that Rothbard said something seemingly contradictory to what I have written? Here is a Rothbard quote from Mish's post followed by a quote from FOA. Tell me if you find them logically inconsistent. Tell me if these quotes by themselves contain enough context to be judged against one another...

Murray Rothbard: Money is not an abstract unit of account. It is not a useless token only good for exchanging. It is not a “claim on society”. It is not a guarantee of a fixed price level. It is simply a commodity.

FOA: As you know we have discussed, at length, how gold is not money; rather it is the very best form of physical wealth barter the world has ever known. We also separated money from gold by defining money as a "retained value thought"; a thought that exists between both sides of a barter transaction as an "associated tradable value". In this, the fiat dollars we know and use today; represent today modern money in the very best of this money context.

Martijn, how would you categorize these two quotes? Would you say that one is more true than the other? If so, why? Do you find them to be irreconcilable? Do you find it is better to stick with textbook definitions of commonly misunderstood words? Or to engage in the free thought process we find within each of us?

Here are a couple more...

Murray Rothbard: Money is a commodity used as a medium of exchange. Like all commodities, it has an existing stock, it faces demands by people to buy and hold it. Like all commodities, its “price” in terms of other goods is determined by the interaction of its total supply, or stock, and the total demand by people to buy and hold it. People “buy” money by selling their goods and services for it, just as they “sell” money when they buy goods and services.

FOA: The result of such thinking draws a conclusion that fits perfectly into our fast paced world. Fiat currency, unbacked except by its legal tender statutes, is a fine immediate trading medium for short term buying and selling. It is best saved for short term use only, and spent to buy any and all forms of real wealth. Of course, if its printing production extremely outpaces even basic GDP, its use value eventually falls.

Thanks for finding those quotes. When I posted those links after reading them I concluded that I had to study ANOTHER and FOA some more.

Generally I would tend to agree with Rothbard that money is a commodity in the sense that it "has an existing stock, it faces demands by people to buy and hold it etc".

However, much of the demand for money stems from its legal tender status and the trust people lie in it (which is among others based upon that very status).

The demand for paper money hence stems from its believed ability to maintain a certain amount of purchasing power over time and the practical way by which is does so (these days it just sits in a computer somewhere and takes up hardly any space, which is quite convenient after all).However, the properties under which money maintains its purchasing power are not restrained by nature, but controlled by humans, as we are now in the process of finding out.

In the quotes above FOA mentions time, while Rothbard doesn't. When one wants to store value over time - which money does - both value and time are of importance. Rothbard mentions value by stressing money being a commodity, but seems to leave time out of the equation.That's half work, isn't it?

I already figured that times comes to you in limited supply as it does to me. I do not necessarily expect feedback from you on all my links, but do appreciate your feedback and discussion should the articles interest you.

Do you find them to be irreconcilable? Do you find it is better to stick with textbook definitions of commonly misunderstood words? Or to engage in the free thought process we find within each of us?

I think that ones own thoughts are a lot more valuable then what someone else has written in a textbook. A textbook can provide great guidance in mapping a trail, but ultimately one can only walk that trail by stepping through ones own thoughts.And all we need for conversation is to try and understand each other. At this forum we seem to be quite successful in that so far, hence the choice to engage in the free thought process seems rather natural to me.

but which is supplied without qualitative differentiation across a market

Depends on how brought we draw the market. A dollar in Chigago is the same as one in LA, Timbuktu or in Tokio. The preferred money varies over the globe, but the various kinds of money are fairly constant all around.

Marx: "The first main function of gold is to supply commodities with the material for the expression of their values, or to represent their values as magnitudes of the same denomination, qualitatively equal and quantitatively comparable. It thus acts as a universal measure of value, and only through performing this function does gold, the specific equivalent commodity, becomes money.

"It is not money that renders the commodities commensurable. Quite the contrary. Because all commodities, as values, are objectified human labour, and therefore in themselves commensurable, their values can be communally measure in one and the same specific commodity, and this commodity can be converted into the common measure of their values, that is into money. Money as a measure of value is the necessary form of appearance of the measure of value which is immanent in commodities, namely labour-time."

Marx: "The commodity is, first of all, an external object, a thing which through its qualities satisfies human needs of whatever kind"

"The usefulness of things make it a use value. But this usefulness does not dangle in mid-air. It is conditioned by the physical properties of the commodity, and has no existence apart from the latter... Use value are only realized in use or in consumption. They constitute the material content of wealth, whatever its social form may be. In the form of society to b considered here they are also the material bearers of ... exchange value.

"Exchange-value appears first of all as the quantitative proportion, in which use-values of one kind exchange for use values of another kind. This relation changes constantly with time and place"

"Gold confronts the other commodities as money only because it previously confronted them as a commodity. Like all other commodities it also functioned as an equivalent, either as a single equivalent in isolated exchanges or as a particular equivalent along side other commodity equivalents. Gradually it began to serve as universal equivalent in narrower or wider fields. As soon as it had won a monopoly of this position in the expression of value for the world of commodities, it became the money commodity..."

Mortymer: "qualitative differentiation" I meant more ... (M1, M2,...)Anyway, isnt it that in inflationary times the velocity determines that money is not commodity as the value of money for those who use them first is higher as they gain most while savers are sucked? How is it with credit? Is that a commodity then?

I think Murray Rothbard and FOA are on the same path in many ways, but perhaps have language difficulties. As you have often pointed out, "money" is a charged word.

My take is that Murray Rothbard is talking about "real" money in a free monetary system, i.e. no legal tender laws and a system of private coinage.

Rothbard did not consider government paper "real" money. From what has Government Done to Our Money:

"Money cannot originate in any other way, neither by everyone suddenly deciding to create money out of useless material, nor by government calling bits of paper "money."

FOA seems be talking about money in the context of current legal tender laws. I think Rothbard would agree that fiat is the current the medium of exchange, but would say it is not "real" money, in no small part because fiat currency is not a store of wealth, its just a legal mandate.

"Money is just as useful when lying "idle" in somebody's cash balance, even in a miser's "hoard." [11] For that money is being held now in wait for possible future exchange--it supplies to its owner, right now, the usefulness of permitting exchanges at any time--present or future--the owner might desire."

Sounds like Freegold, like Rothbard's "real" money "is the very best form of physical wealth barter the world has ever known."

I read Rothbard throughout his works as saying if we let the free market dictate things, which is basically what happens when a currency collapses, real money will show itself. Silver will have some value, as may other industrial commodities. Money is a commodity people value. But the best form of money, the wealth reserve par excellence, is gold.

Freegold to me is a free market move, an effective repeal of legal tender laws. People realizing fiat's inherent worthlessness, leading towards market anarchy in currency, which is what Murray Rothbard is all about.

Murray Rothbard certainly agreed fiat money "is best saved for short term use only, and spent to buy any and all forms of real wealth," because fiat was not real money. He liked gold too.

I think this article might be a "must read". I assume the writer is the Alf Field in Jim Sinclair's dictum "alf's numbers and armstrong's timing".

http://www.kitco.com/ind/Field/nov112009.html

It is a report on AF's recent trip to Zimbabwe and his analysis of their journey through hyperinflation to a "free market in money" (my description in inverted commas).

FWIW this is a link to Martin Armstrongs latest essay on Gold.

http://economicedge.blogspot.com/

Lastly, my contribution to the earlier discussions (gold vs the rest) boils down to this. I think the message is to exit everything that has any counter-party risk unless you are 100% certain the counter-party can and will perform.

I would appreciate your views on where counter-party risk would be most extreme if/when Freegold happens.

On the way to freegold, I think it is obvious that the most extreme counterparty risk is in paper gold. But once a new freegold stasis has been established, I think it will be in "fixed income investments". In other words, the bond market will disappear. The problem with bonds is that you have two counterparties. You have the bond issuer, and you have the fiat printer. (The liquidity of the bond market is also a third counterparty in the event of emergency liquidation needs, like a health crisis) Either one can default on you in different ways. And in freegold, the bond market will become highly illiquid and then disappear as gold absorbs this function.

The current view on "fixed income investments" for retirees is a bit of a shell game. It states that you never touch your principle and you live off the interest (assuming you have saved enough principle). But the fact of the matter is that the purchasing power of the principle, over the long run, erodes faster than the interest you spend. For older people this is mostly masked by the span of retired life not quite reaching "the long run". But as we transition to freegold "the long run" will be compressed.

This erosion effect can be seen today in the diminished purchasing power of the estates left behind when compared to the beginning of retirement. In freegold, they will do better with less risk. Even though you will be eating away at your principle denominated in gold, it will float against the paper world and the real economy in a way that is better than, and less risky than the current bond market.

It is true that many retired people's portfolios have outrun inflation quite well. But they were always at greater risk than was advertised. And the full extent of that risk will soon be revealed. The big surprise is that Ben Bernanke is a co-counterparty to every single dollar-denominated bond in the world. And every dollar he prints is one more paper cut in the death by a million little paper cuts.

About confiscation and taxation... both of these things will increase the probability of very big black market.. and most of people buy the gold for holding it for at least 10y right?!... so my point is you will have enough time to find a way to sell it.

I was quite young then, and didn't know anything at all. I just reached 18, when the hyperinflation broke out. Honestly, I can't tell you much about gold, because it didn't exist in my experience. I can only tell you what I was smart enough to notice.

First, when you talk USSR, you have to understand that we were living inside a propaganda aquarium that was inside of the propaganda aquarium that exists from our common point of view today. Meaning, that for us then, to know the truth as average American knows it, was a huge progress already, unthinkable, and you could find may-be one in a hundred (may-be) who even knew enough to understand that USSR is just a big bold lie. I am not aware of any single soul who knew more than that, no-one who could participate in this current discussion.

Gold. All we knew about it is that urinals supposed to be made of it when we reach the communist prosperity. And, a lie that USD is backed by gold. Nothing else about it. We knew that Stalin mined gold, and that gold mines are still in operation, but we thought it was all for the jewelry. I did not know that Stalin purchased every bit of "landlease" from US for pure gold, until I was here. They told us that "landlease" was a completely free, selfless gift from the United States, and that without that gift, we would have fell under Germany. As far as I know, every honest person loved US for that magic help in the worst time.

At any time before and during hyperinflation, one could go to the swapmeet and sell his jewelry to gypsies. This was a better deal that Soviet "ALMAZ", a government run jewelry store that was the only other purchaser of gold. ALMAZ was giving us a penny on a dollar and Gypsies were giving us two, but were much more riskier to deal with, as they used all kinds of tricks.

Most everyone I know sold their family gold, what small amounts they had, to survive the hyperinflation. Sold for nothing, due to widespread lack of knowledge and consequently lack of marked, also helped by import controls and price controls.

Personally, I had no gold. My father was an important communist, and my mom was a typist. Our family heirlooms were taken back during the revolution, in 1917.

My mom paid for 18 years into my "maturity fund", which sat in the Savings Bank and accumulated tiny interest. As I reached 18, then a withdrawal could be made. This was a thousand rubles, big enough to buy several boxes (not cartons) of imported cigarettes. Through her cries I did just that and hide it all. About a week later, the news anchor said that the rumors of devaluation were completely off base. The next day, Saturday, the finance minister personally assured everyone on TV, that everything is honky dory and no devaluation is even in the plans.

The devaluation announcement was made on Sunday, yes, the next day after that. Suddenly, all money were not good for anything. You had to stand in a huge line to get in to the bank and then to exchange only a small amount of old money into the new banknotes 1 to 1. Everything above that, burned.

After that, the price increases really started in earnest. I couldn't decide what to do with my smokes, because the prices were going up so fast.

So, we were surviving like most everyone, by stealing from factory plants. Somehow, all of that industrial high quality stuff ended up abroad. I saw it all on swapmeets in Turkey, few years later. Wherever one had been working, this is were he took the stuff from. Again, I can't trace it for you who was providing the other side of transactions, as I wasn't asking myself those questions.

When prices finally began to stabilize, the country was swept clean, of most of the industrial base. This is how we paid for it.

Those who just purchased homes, found themselves to be able to pay them off awesomely quick, because prices were increasing faster than any interest owed, and the salaries were increasing too, although at a magnitude slower pace, but still much faster than the rate of interest. Some folks made last bulk payments equating years of normal payments with just their last paychecks.

But this was happening only to relatively high income ones. Those on the bottom, saw real estate prices running away forever.

I sold my smokes pack by pack, basically where there were no stores, along with smuggled moonshine. Smokes turned out to be the ultimate store of value par excellence even showing some ROI. I can't think of any other commodity that did so good and wasn't perishable as sugar, tires and flour that other folks hoarded.I have found out that this is the single item that is always in demand, and easily traded and sold.Smokes were also easy to buy in bulk even as the whole thing already started to slowly unfold.

I say that this is the item to spend the last paper that you know will burn, but it is too late to buy food or better stuff. Some people had literally warehouses of tobacco products.

So, that is it. I am sorry I can't tell you anything useful about gold.

Paper gold, fixed interest obligations (such as bonds) and derivatives make up the top three on my list of counter-party risks.

Assuming, for the sake of argument, that a panic over fiat currency provides the launch pad for Freegold. If I understand the concept, perversely, Freegold will make the fiat "safe" as a short term holding.

In countries where capital gains are more favourably taxed than income this could provide a window to exit some gold to local fiat before, say, the PTB get a windfall tax on gold in place (in response to the Freegold moonshot).

Counter-intuitive for us gold bugs but if FOFOA is right the Giants plan to cash in. If legal tender laws remain in place in order to pick up the bargains they would have to exchange gold into fiat currency.

Perhaps part of the play is to obtain large amounts of fiat for small amounts of gold when the public are trying to exit fiat in a panic. In other words when the period of maximum danger in fiat has already passed.

The fiat obtained in large quantities, because of huge discount, as you say, after the worst is passed, still has a huge risk to it.

Typically, it will not be the fiat used further. It will take only a simple denomination, to render it useless, unless you could purchase the assistance of great many to help you to exchange it for new fiat. Or, if you have someone you could bribe, to accomplish the same thing.

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